M8-1 LO1, 3, 6



M8-1 LO1, 3, 6

Classifying Long-Lived Assets and Related Cost Allocation Concepts

For each of the following long-lived assets, indicate its nature and related cost allocation concept. Use the following symbols:

Nature                                                  Cost Allocation Concept

L      Land               &nbs p;                             DR    Depreciation

B      Building             & nbsp;                         DP    Depletion

E      Equipment            &n bsp;                      A       Amortization

NR   Natural resources                        NO    No cost allocation

I       Intangible      ;                               O      Other

O     Other

                  Asset                   &nb sp;                   Nature                     Cost Allocation

1.     Copy right                                    -------                        ---------------

2.     Land held for use                  &nb sp;       -------                        ---------------

3. & nbsp;   Warehouse                                    ------                         ---------------

4.     Oil well                                          -------                        ---------------

5.     New engine for old machine        -------                        ---------------

6.     Operation license   &n bsp;                     -------                        ---------------

7.     Land held for sale                       &nbs p; ------                         ---------------

8.     Delivery vans              & nbsp;                -------                        ---------------

9.     Timber tract                            &nb sp;     -------                        --------------

10.     Production plant            &n bsp;              -------                        --------------

| | | |Cost |

| |Asset |Nature |Allocation Concept |

|(1) |Copyright |I |A |

|(2) |Land held for use |L |NO |

|(3) |Warehouse |B |DR |

|(4) |Oil well |NR |DP |

|(5) |New engine for old machine |E |DR |

|(6) |Operating license |I |A |

|(7) |Land held for sale |O (investment) |NO |

|(8) |Delivery vans |E |DR |

|(9) |Timber tract |NR |DP |

|(10) |Production plant |B |DR |

M8-2 LO1

Computing and Evaluating the Fixed Asset Turnover Ratio

The following information was reported by Cutter’s Air Cargo Services for 2007:

Net fixed assets (beginning of year)                        $1,500,000

Net fixed assets (end of year)                                    2,300,000

Net sales for the year                      ;                            3,300,000

Net income for the year                                             1,600,000

Compute the company’s fixed asset turnover ratio for the year. What can you say about Cutter’s ratio when compared to Southwest’s 2007 ratio?

Cutter’s fixed asset turnover ratio is

= Net sales

[(Beginning net fixed asset balance + Ending net fixed asset balance) ( 2]

= [pic]

= 1.74

Cutter’s ratio is higher than Delta’s 2007 ratio of 0.94 indicating that Cutter may be somewhat more efficient in its use of fixed assets.

M8-3 LO2

Indentifying Capital and Revenue Expenditures

For each of the following items, enter the correct letter to the left to show the type of expenditure. Use the following:

Type of Expenditure                      Transactions

C     Capital expenditure               ----- (1) Paid $400 for ordinary repairs

R     Revenue expenditure            ----- (2) Paid $6,000 for extraordinary repairs

N    Neither                                   ----- (3) Paid $20,000, for addition to old building

                                                ----- (4) Paid for routine maintenance, $200, on credit

                                               ------ (5) Purchased a machine, $7,000; gave long-term note

                    &n bsp;                           ----- (6) Paid three-year insurance premium, $900.

                    &n bsp;                           ----- (7) Purchased a patent, $4,300 cash.

          &n bsp;                                     ___ (8) Paid $10,000 for monthly salaries.

                   &nbs p;                           ____ (9) Paid cash dividends, $20,000

(1) R; (2) C; (3) C; (4) R ; (5) C; (6) N; (7) C; (8) R; (9) N.

M8-4 LO3

Computing Book Value (Straight-Line Depreciation) (Show your work)

Calculate the book value of a three-year-old machine that cost $21,000, has an estimated residual value of $1,000, and has an estimated useful life of four years. The company uses straight-line depreciation.

Machinery (original cost) $21,000

Accumulated depreciation at end of third year

Depreciation expense =

($21,000 cost – $1,000 residual value) x 1/4 years = $5,000

Accumulated depreciation = $5,000 annual depreciation expense x 3 yrs = 15,000

Net book value at the end of the third year $6,000

M8-6 L03

Computing Book Value (Units-of-Production Depreciation) (Show your work)

Calculate the book value of a four-year-old machine that cost $21,000, has an estimated residual value of $1,000, and has an estimated useful life of 20,000 machine hours. The company uses units-of-production depreciation and ran the machine 3,200 hours in year 1,   7,050 hours in year 2,     7,500 hours in year 3

Machinery (original cost) $21,000

Accumulated depreciation at end of third year

Depreciation expense per machine hour

= [pic] = $1

Accumulated depreciation Yr 1 Yr 2 Yr 3

= $1 depreciation expense per machine hr x (3,200+7,050+7,500) hrs = 17,750

Net book value at end of third year $3,250

M8-8LO5

Recording the Disposal of a Long-Lived Asset (Straight-Line Depreciation)(Show your work)

As part of a major renovation at the beginning of the year, Mullin’s Pharmacy, Inc., sold shelving units (store fixtures) that were 10 years old for $3,000 cash. The original cost of the shelves was $6,000 and had been depreciated on a straight-line basis over an estimated useful life of 13 years with an estimated residual value of $800. Record the sale of the shelving units.

Store fixtures (original cost) $6,000

Accumulated depreciation at end of tenth year

Depreciation expense =

($6,000 cost – $800 residual value) x 1/13 years = $400

Accumulated depreciation = $400 annual depreciation expense x 10 yrs = 4,000

Net book value at end of tenth year (i.e., NBV immediately prior to sale) $2,000

Journal entry to record the disposal is as follows.

Cash (+A) 3,000

Accumulated depreciation, store fixtures ((XA, +A) 4,000

Store fixtures ((A) 6,000

Gain on sale of store fixtures (+Gain, +SE) 1,000

E8-11 LO3, 7

Computing Depreciation and Book Value for Two Years Using Alternative Depreciation Methods and Interpreting the Impact on Cash Flows

Daisy Company brought a machine for $66,000 cash. The estimated useful life was four years, and the estimated residual value was $6,000. Assume that the estimated useful life in productive units is 120,000. Units actually produced were 43,000 in year 1 and 45,000 in year 2

Required:

1.     Determine the appropriate amounts to complete the following schedule. Show computations, and round to the nearest dollar.

                                        Depreciation Expense for       Net Book Value at the End of

Method of Depreciation            Year 1      Year 2                 Year 1        Year 2

Straight-line

Units –of-production

Double-declining-balance

| |Depreciation Expense | |Book Value at End of |

|Method of Depreciation |Year 1 | |Year 2 | |Year 1 | |Year 2 |

|Straight-line |$15,000 | |$15,000 | |$51,000 | |$36,000 |

|Units-of-production |21,500 | |22,500 | |44,500 | |22,000 |

|Double-declining-balance |33,000 | |16,500 | |33,000 | |16,500 |

Computations:

Amount to be depreciated: $66,000 – $6,000 = $60,000:

Straight-line: $60,000 ( 4 years = $15,000 per year

Units-of-production: $60,000 ( 120,000 units = $.50 per unit

|Year 1: |43,000 x $.50 |= |$21,500 |

|Year 2: |45,000 x $.50 |= |$22,500 |

Double-declining-balance (Rate: 2 x the straight line rate of 25% (2/4) = 50%):

| |Year 1: | | $66,000 x 50% = $33,000 |

| |Year 2: | |($66,000 – $33,000) x 50% = $16,500 |

2. Which method would result in the lowest EPS for year 1?   For year 2?

The double-declining balance method would result in the lowest EPS for Year 1 because it produced the highest depreciation expense and therefore the lowest income (from Requirement 1 above). In Year 2, the units-of-production method would result in the lowest EPS because it produced the highest depreciation expense and therefore the lowest income in that year.

3. Which method would result in the highest amount of cash outflows in year 1? Why?

Depreciation is a noncash expense; that is, no cash is paid when depreciation is recognized. Ignoring income tax implications, all methods have the same impact on cash flows in year 1. Assuming a method is applied for tax determination, the straight-line method will result in the lowest expense, highest net income, highest tax liability, and therefore the highest amount of cash outflows in year 1. Companies will select methods for tax purposes that reduce tax obligations.

4. Indicate the effects of (a) acquiring the machine and (b) recording annual depreciation on the operating and investing activities sections of the statement of cash flows (indirect method) for year 1 (assume the straight-line method).

The machine acquisition would decrease cash provided by investing activities by the purchase cost of $66,000. As a noncash expense, the annual depreciation should have no overall effect on cash provided by operating activities—however, because it is originally subtracted to arrive at net income, an adjustment needs to be made to reverse this effect for cash flows. Hence, $15,000 (the annual straight-line depreciation) must be added back to net income in the operating section of the statement of cash flows.

E8-12 LO4, 5

Inferring Asset Impairment and Recording Disposal of an Asset

United Parcel Service state in a recent 10-K report, “We are the world’s largest package delivery company and a leading global provider of specialized transportation and logistics services,” The following note and data were reported:

Note 1-Summary of Accounting Policies

Impairment of Long-Lived Assets

We review long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset….In December (of a recent year), we permanently removed from service a number of Boeing 727 and DC-8 aircraft. As a result, we conducted an impairment evaluation, which result in…

                 &nb sp;                                                              Dollars in Million

Cost of property and equipment (beginning of Year)      $25,361

Cost of property and equipment (ending of year)              26,915

Capital expenditures during the year                                   1,947

Accumulated depreciation (beginning of year)                  11, 749

Accumulated depreciation (ending of year)                      13,007

Depreciation expense during the year                                  1,549

Cost of property and equipment sold during the year             318

Accumulated depreciation on property sold                           291

Cash received on property sold                                               118

Required:

1.     Reconstruct the journal entry for the disposal of property and equipment during the year.

|Property, Plant, and Equipment |

|Beg. Bal |25,361 | 318 |Property sold |

|Capital expenditures |1,947 |75 |Write-offs |

|End. Bal. |26,915 | | |

|Accumulated Depreciation |

|Property sold | 291 |11,749 |Beg. bal. |

| | | 1,549 |Depreciation expense |

| | |13,007 |End. bal. |

Disposal of property and equipment:

| Cash (+A) |118 | | |

| Accumulated depreciation ((XA, +A) |291 | | |

|  Property and equipment ((A) | | |318 |

| Gain on sale of property and equipment (+Gain, +SE) | | |91 |

2.     Compute the amount of property and equipment that United Parcel wrote off as impaired during the year. (Hint: Set up T-accounts)

Amount of property and equipment written off as impaired during the year:

|Beginning balance |$25,361 |

|+ Capital expenditures during year |1,947 |

| - Cost of property sold during year |(318) |

| - Impairment loss during year | (?) |

|Ending balance |$26,915 |

Impairment loss = $75

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